This copy is for your personal, non-commercial use only. To order presentation-ready copies for distribution to your colleagues, clients or customers, click the "Reprints" link at the top of any article.

Repo Market Changes Happening Faster

Fed said to press BNY Mellon to speed market reforms.

The Federal Reserve, seeking to cut risks in the financial system, is pushing Bank of New York Mellon Corp. to speed changes in a $1.8 trillion bond-lending market that helped fuel the 2008 crisis.

BNY Mellon, which handles about 80 percent of loans in the so-called triparty repo market, will complete computer upgrades and projects aimed at bolstering the system by 2014, two years earlier than planned, according to a document on its website. The bank had pledged in February to finish the tasks by 2016, prompting the Fed to criticize industry-led reforms as too slow.

Since then, the Fed has used its supervisory powers to get quicker results, said three people with knowledge of the matter, who requested anonymity because the talks are confidential. JPMorgan Chase & Co., which clears the rest of triparty repo trades, previously agreed to complete reforms before 2014. The upgrades would make the market less prone to the panics that destroyed Bear Stearns Cos. in 2008 and triggered a $148 billion Fed bailout program to keep other brokerages from collapsing.

“The Fed continues to view repo as an outstanding risk,” said Josh Galper, a former Merrill Lynch & Co. executive who’s now managing principal of Finadium LLC, a securities-lending consultant in Concord, Massachusetts. “So they have made it clear that they want the process to move faster.”

The triparty repo market is used by Wall Street dealers including Goldman Sachs Group Inc. and Morgan Stanley to finance bond holdings. They borrow cash from money-market mutual funds, commercial banks and corporate treasurers, with the bonds pledged as collateral to secure the loans.

BNY Mellon and JPMorgan act as middlemen to process the transactions and keep charge of the collateral. The role requires the two New York-based banks to temporarily extend hundreds of billions of dollars in credit each day, putting their safety at risk if the market breaks down. The Fed’s goal is to eliminate the need for the lenders to finance the deals, the people said.

Fed Chairman Ben S. Bernanke told the Financial Crisis Inquiry Commission that a breakdown of the triparty market in 2008 almost created a “black hole” as financial firms lost access to cash for daily operations. The commission in a report cited structural flaws in the market as one of the biggest causes of the crisis.

Unlike reforms mandated by the 2010 Dodd-Frank Act -- such as requiring more derivatives trades to go through central processing hubs with higher collateral requirements -- there were no laws requiring changes in the triparty repo market.

Instead the Fed has used its supervisory powers over the banks to push them to enhance their operations to reduce the systemic threat, said the people with knowledge of the matter. The Federal Reserve Bank of New York oversees the holding companies for BNY Mellon and JPMorgan.

Daily Decisions

Transactions in the triparty repo market historically have gone through a daily “unwind,” where cash is returned to the money funds that lent it and the collateral is returned to the dealers so they can make changes or substitutions based on assets coming in and out of their firms. The positions are then re-established or “rewound” hours later.

Until then, the clearing banks -- BNY Mellon and JPMorgan -- provide credit to the dealers, such as Goldman Sachs, to replace the cash that was returned. This means the clearing banks must decide every morning whether to provide credit to the dealers, and leaves those clearing banks on the hook if a dealer gets into financial trouble.

Fed officials have said they want to eliminate the need for the clearing banks to provide credit during the day, and to devise a strategy for liquidating collateral if a dealer defaults.

“What the Fed wants is for the unwind-rewind to become what they call an operational moment in time, effectively instantaneous,” said Finadium’s Galper.

An industry task force that included the cash lenders Fidelity Investments and Federated Investors Inc. published a report in February outlining steps to reduce the amount of intraday credit from the clearing banks. The drawback: BNY Mellon’s enhancements wouldn’t be in place until 2016.

That prompted the New York Fed to publish a statement saying it would “intensify its direct oversight of the infrastructure changes” because the task force had “not proved to be an effective mechanism.” The task force was disbanded, and in the ensuing months the Fed used its supervisory powers to pressure the clearing banks to speed their efforts, said the people with knowledge of the matter.

“We have heartily endorsed meaningful reforms,” Karen Peetz, a BNY Mellon vice chairman, told a Senate panel last month. The bank already has completed some changes, including shortening the time each day when the firm is directly extending credit to Wall Street firms to three hours from 10, she said.

The measures should cut the company’s “intraday exposure” by about $230 billion by early next year, she said.

According to the document posted on BNY Mellon’s website, the bank will complete necessary upgrades to allow “rolling settlement of maturities” by 2014. In the February task force report, that project wouldn’t have been completed until 2016.

Andrea Priest, a spokeswoman for the New York Fed, declined to comment. The regulator said in a July statement it would “use all supervisory tools at its disposal to encourage constructive and timely action to reduce sources of instability in the triparty market.”

“Clearing banks must introduce changes to their technology, policies and procedures,” the Fed said.

The Fed is separately pushing Wall Street dealers to curb their reliance on the financing, and will “closely monitor the actions of market participants” over the next several months, according to the July statement.

“BNY Mellon is fully committed to supporting U.S. triparty repo market reforms that are geared toward reducing systemic risk,” according to the undated document. “The original target completion date has been accelerated by two years.” Kevin Heine, BNY Mellon’s spokesman, declined to say when the document was published or to comment on the reforms.

Justin Perras, a spokesman for JPMorgan, declined to comment. The bank says on its website that it has agreed with the New York Fed to complete reforms by an “aggressive target” of year-end 2013.

Even by the end of 2012, the firm will “hit three key milestones” that will “eliminate a portion of the financing requirements that dealers and cash investors currently cope with on a daily basis,” JPMorgan said. The New York Fed “has assumed a larger role in monitoring execution and providing governance and oversight.”

The bank spokesmen didn’t disclose how much their firms earn in fees from triparty clearing. At BNY Mellon, the business is part of the asset-servicing unit, which produced $3.7 billion of fees last year, according to the annual report. The unit alone spends about $1 billion a year on technology, more than any other part of the company, asset-servicing chief Timothy Keaney said at an investment conference on Sept. 11.

Treasury & Risk

Treasury & Risk is an online publication and robust website designed to meet the information needs of finance, treasury, and risk management professionals. Our editorial content, delivered through multiple interactive channels, mixes strategic insights from thought leaders with in-depth analysis of best practices, original research projects, and case studies with corporate innovators.